The Housing Chronicles Blog: What's really going on with the economy?

Thursday, February 26, 2009

What's really going on with the economy?

Recession or depression? Inflation or deflation? A bend or a new trend?

Confused about the differing opinions regarding the economy from various pundits and economists? We asked Chris Thornberg, a founding principal of MetroIntelligence partner Beacon Economics, for his thoughts on what's really going on with the U.S. economy, featured below but also to appear in the March issue of Builder & Developer magazine.

For those of you who don't know him, Christopher Thornberg PhD, is an economist and a founding principal of Beacon Economics, an economic research and consulting firm. Chris and I have worked together since early 2008 on various real estate-related consulting projects, allowing us to provide a level of sophistication in modeling and forecasting which I believe was previously unavailable to the building industry. We don't just repurpose data from other sources, slap our brand on it and then send you an invoice -- we tell you what it really means.

"What's really going on with the economy?"

by Christopher Thornberg

Over the last several months, it’s been very easy to get caught up in hysterical headlines regarding the economy, or witness the ensuing panic among the world’s greatest drama queens -- otherwise known as Wall Street traders. But as I drive in Southern California to various meetings or hop on a plane to give a speech, the world still seems to be operating much as it always has. So what’s really going on?

When economic growth occurs, because it depends on the behavior and actions of human beings, it doesn’t do so smoothly: it arrives in trends and bends. Trends are based on long-run factors such as demographics, productivity, investments and public policy. Bends are based on short-run factors driven by imbalances, and a recession is simply a negative bend required to rebalance the economy to long-term trend lines.

Yes, we are clearly in a recession, one which was fully underway as early as the first quarter of 2008 (or even the fourth quarter of 2007) despite the ongoing denials at that time by most economists and politicians. And yes, this recession is different than some others in the past because it was caused by imbalances in not just one or two factors, but three: housing, finance and consumer spending.

When the housing pyramid finally collapsed in 2007, it did so because prices were seriously out of whack regarding household incomes and what a home might rent for on the open market. The building of this pyramid was fed by the ridiculous availability of easy credit to anyone who could fog a mirror, made possible by too much money sloshing around the world in search of an easy return. The titans of Wall Street, focused on short-term gains and enabled by ratings agencies to leverage borrowed money to ratios that were unsustainable, ignored the long-term ramifications of their financial alchemy simply because they could.

But so did the average American consumer, who collectively bid up the total value of U.S. assets to $80 trillion dollars, yielding a national price-to-earnings ratios (asset values vs. earnings) that was 25% to 30% higher than its long-term average. Consequently, the true sin of Wall Street isn’t that they robbed Baby Boomers of their plans for early retirement, but that they actually made them think it was possible at all. It may not make you feel better, but that extra wealth, which could total $20 trillion, was really never there in the first place.

So where do we go from here? To be certain, things are bad, but not as bad as pundits and politicians would have you believe. For one thing, the pullback in consumer spending is a good thing for an economic rebound because Americans need to re-learn how to save. So far they’re quick studies, with the savings rate already up to 4% -- about half of where it needs to be before it will again re-align with the appropriate amount of spending not financed by debt. Barring any more huge shocks to the economy, the general recovery – tepid as it will likely be – should occur around mid-2010. But between the peak and trough, we’re looking for an aggregate loss of 3.7% to U.S. GDP, so the pain will be real but essential to return the economy to long-term health.

For the building industry, you’ll just have to be a bit more patient. Given how huge this last bubble inflated, it will take more time for the market to wring out its excesses, so the recovery for housing will probably be delayed until 2012. When housing does hit bottom, rather than experiencing a nice bounce like in the past, it will simply dribble on the ground until household finances and consumer sentiment catch up. Yet in the long run, lower prices are the best medicine for an industry that requires affordable housing in order to operate. For now, resist the urge to panic. There’s a reason why many people believe that the Chinese character for the word “crisis” translates as “danger plus opportunity," although others think it just means "crisis." Either way, patience and planning will eventually win out.

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2 comments:

Maciej C said...

"There’s a reason the Chinese character for the word “crisis” translates as “danger plus opportunity."

Except that it doesn't. See http://www.pinyin.info/chinese/crisis.html for a thorough debunking.

Anonymous said...

"So where do we go from here? To be certain, things are bad, but not as bad as pundits and politicians would have you believe. "

If you have facts to support your position please post them. You are not arguing anything in this article.

We've never been here before.